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Don't Lose Your Shirt With These Stocks

If GDP is about to turn negative, discretionary stocks are poised to fall.

As investors, we'd all love a crystal ball. For the foreseeable future (pardon the pun), that'll remain a pipe dream. But the next-best thing may be the economic indexes published by the Consumer Metrics Institute. In recent years, these data series have accurately forecast upturns and downturns in both the economy and the stock market.

These days, the institute's key consumer demand index is showing that the U.S. economic recovery is about to be -- as the bond market has predicted -- definitively kneecapped. Specifically, the index is indicating a 2% contraction in third- quarter gross domestic product. Ouch!

For those who've been keeping score, such a read on things contrasts sharply with first-quarter GDP growth, which, although recently revised downward by 0.2%, still came in at a modestly encouraging 3%. Ah, but it all comes down to which data points are monitored and how the numbers are crunched.

See, methodologies used by the Bureau of Economic Analysis (the government agency responsible for calculating GDP and other key statistics) are arguably stuck in the past, more relevant to the economy of yore than today's incarnation. And at best, because GDP measures economic output -- or supply side activity -- it is destined to be a lagging indicator.

On the other hand, the Consumer Metrics Institute monitors economic activity at the point of initial consumer demand, offering investors a near-real-time picture of the spending dynamics that are likely to show up in future quarters' GDP. Importantly, the institute's methodologies appear to have been extensively tested, with tinkering beginning in 2004, continuing through the financial crisis, and finalization and first publication arriving in summer 2009.

So with all this in mind, what's the takeaway for investors? In a phrase, get defensive. And that goes twice for retail stock investors, who at the very least should consider the valuation gap between high- and low-end names, as the table below indicates.

Company

Price Tier

TTM P/E

Forward P/E

Dividend Yield

TJX Companies(NYSE: TJX)

Off-price (20% to 60% discount to department stores)

14.5

12.3

1.3%

Ross Stores(Nasdaq: ROST)

Off-price (20% to 60% discount to department stores)

14.4

12.2

1.2%

Kohl's(NYSE: KSS)

Mid/value

14.9

11.9

N/A

J. C. Penney(NYSE: JCP)

Mid

21.8

12.3

3.1%

Coach(NYSE: COH)

Premium ("accessible luxury")

19.6

16.7

1.5%

Saks(NYSE: SKS)

Premium and "off-price luxury"

N/A*

40.2

N/A

Abercrombie & Fitch(NYSE: ANF)

Premium

66.9

13.6

2%

Data from Yahoo! Finance on June 10. TTM = trailing 12 months.

*Negative earnings in trailing 12 months.

In general, the off-price and value retailers offer more sober valuations, which may become even more attractive if premium-brand consumers start to trade down in coming months. As for Abercrombie & Fitch, shares appear to be a steal on a forward price-to-earnings basis, but investors would do well to keep in mind that analysts are chronically overoptimistic.

Now, let's acknowledge that the Consumer Metrics Institute's forecast of minus 2% GDP in the third quarter may be extreme. The institute's methodologies do, after all, have their shortcomings, including the fact that consumer sampling is limited to Internet-based discretionary purchase activities.

But combined with other factors -- for instance, the stagnation in real organic personal income, crummy retail sales in April and now again in May, and the still-lingering specter of deflation -- a conservative investing stance seems a no-brainer.